The word ‘Budget’ is occupying a large and generally unsettling space in our national conversation and collective imaginations. We’re nearing the crescendo of many months of speculation and soon we will have some certainty regarding the chancellor’s plans to address the challenges facing the nation’s finances.
For financial advisers and the industry at large there’s a sense of trepidation, in part because we are still in the midst of the fallout of last year’s Budget and plans to include pensions within IHT.
Of all the changes speculated on ahead of last year’s statement (and speculated about again this year…), from changes to pensions tax-free cash or rates of tax relief, the decision to make pensions liable for IHT was, on the face of it, one of the more modest proposals.
After all, the government estimate around 1.5% of total UK deaths will become liable for IHT where this would not previously have been the case.
Despite an interest in alternatives, 72% advisers think pensions will retain their enduring appeal
The reality is that for financial advisers this is a change with very significant implications. From the conversations I’ve had, it’s clear that the current industry discussion doesn’t fully reflect the level of work the change will entail and we’ve undertaken some research to try and quantify the impact.
IHT workload underestimated
Three-quarters (77%) of advisers we spoke to said the changes would result in an increase in workload. This is understandable when advisers estimate 40% of clients will need a review of financial plans. When asked to estimate the additional workload this would create, advisers on average put the figure at a 20% uplift.
Turning planning assumptions on their heads
It’s been clear since the chancellor sat down from the despatch box last year that one of the central tenants of financial planning in the post-pension freedoms era would need a rethink.
The principle that saving within a pension was the most, or one of the most, tax-efficient ways for the wealthiest individuals to pass money on requires another look. For some advisers, particularly those who’ve entered the industry in the last ten years, there’s been much more limited use of alternative product solutions.
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Our research found that 57% of advisers estimated they would need to refresh or improve their knowledge on alternative strategies. Trusts, onshore and offshore bonds, gifting strategies and annuities were all identified as an important part of an updated adviser toolkit.
The research tallies with some of the activity we’ve been running. Our recent IHT webinar for advisers attracted nearly 1,000 registrations and generated around 100 follow-up questions. Some of the most common questions focused on ways to reduce pension IHT exposure and also the role annuities.
Enduring appeal of pensions
Despite an interest in alternatives, 72% advisers think pensions will retain their enduring appeal. This is because for most individuals pensions have the potential to give a better pound-for-pound outcome based on tax-relieved premiums than saving into other assets – even when the beneficiaries pay IHT on the proceeds.
A basic-rate taxpayer investing £20,000 in an Isa might see it grow to around £29,600 over ten years, whereas the same amount in a pension could reach £37,000 due to tax relief. For higher-rate taxpayers, the potential uplift is even greater.
Employer contributions for those in a workplace pension schemes also makes a significant difference to future fund values.
Actions to consider today
The other big factor at play here is the lack of clarity around the final rules and the relatively short period until the changes come into effect – a majority of advisers (53%) believe timeframes are too tight.
That said, there are a number of steps advisers can take to get ahead of the changes. One is to consider consolidating pensions. Doing so is likely to reduce the administrative burden for beneficiaries after death, although care should be taken if this involves giving up any valuable policy guarantees.
Just 4.62% of UK deaths resulted in an IHT charge and yet it’s arguably the most hated element of our tax system
Another option is to review the investment strategies being used for those clients whose estates may exceed the IHT threshold. Reviewing whether growth is the best option for investments that might be retained, for example, is worth considering with clients.
The gifting from surplus income rules are prompting a renewed interest in annuities, especially given the higher rates on offer at the moment. Just over half of our annuity sales are now advised, up from 38% a year ago – although annuities might not be suitable for those who want a higher degree of flexibility to withdraw money as needed.
Maintaining trust through change
IHT has always been a poorly understood tax. Just 4.62% of UK deaths resulted in an IHT charge in the latest reporting period and yet it’s arguably the most hated element of our tax system.
The long-term effects of these changes are not yet understood, but it would be very unfortunate if one of them was to disincentivise those never likely to pay IHT from pension saving.
At a time when the vast majority of private sector workers are not putting enough aside to secure a comfortable retirement, the behavioural aspect of pension changes need to be carefully considered.
As the chancellor gears up to deliver her Budget, we hope that the implications of mooted changes to areas like salary sacrifice will be carefully considered. As we see with pensions and IHT, even the more modest changes can create big ripples.
Colin Williams is CEO of pensions & savings at Standard Life
